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$435M FOR A SEAT AT THE TABLE

Few jurisdictions are less attractive than Illinois from a casino investment standpoint. Yet there were no shortage of bidders for the State’s 10th and last license. Bids ranged from $60 million (dumb) to $435 million (and dumber). And that’s just for the right to operate a casino in this socialist state. Never mind land and construction costs.

Assuming the $435 million bid wins (loses), the all in investment cost will certainly approach $1 billion. I don’t think there is one existing Illinois casino property that will generate more than $55 million in EBITDA this year, and likely less next year. Even if the new casino can drive $100 million in the face of the most onerous tax structure, a 100% smoking ban, and an uncertain consumer environment, a 10% ROI is not very appealing.

The only encouraging take away is that no public gaming entity even bothered to enter a bid. BYD, PENN, and WYNN are the only companies with the actual resources to even face that decision. They all made the right one.

WHEN CASH ISN’T KING, NOR EVEN ROYALTY

In this environment, one would expect a stock that is down 85% YTD to be an overleveraged, covenant busting, illiquid, and free cash flow negative company lacking hard assets. While many of these adjectives apply to many companies within the gaming sector, none accurately describes Boyd Gaming. Oh and by the way, BYD should generate $2 per share in free cash flow next year for a 40% yield. That’s 40% after all capex and is based on reasonable numbers, not the Street’s.

No one is making the case that BYD’s fundamentals are rock solid right now or their upcoming quarter will be good. Quite the opposite. However, I don’t need to whip out my calculator to know that even if my discounted estimates are cut in half, the FCF yield would still be a whopping 20%.

From a liquidity standpoint, BYD has no significant maturities until 2013. Covenants shouldn’t be an issue either as leverage is coming down at the same time the leverage restriction rises. Please see the chart. EBITDA would have to fall over 25% below my estimate in Q4 to bust a covenant. Not likely.

Something is going on here. BYD dropped 13% today when the DOW rocketed up 400 points. Even HOT was up today. Somebody is blowing up.

Even in Q4 BYD maintains significant leeway before busing the leverage covenant

Explosion: Why We Bought/Covered This Morning...

EXPLOSION
The VIX hits an all time high

Market pundits are using the term “unprecedented” to describe the levels we are seeing in the options market -for once they are right, there is no real historical corollary for the current volatility environment. The VIX spiked to all time high levels today as equity investors across the entire duration spectrum struggle to find their footing. As you can see from the attached chart this is a global options market phenomenon as every short gamma trader on the planet is scrambling to buy and cover because their models no longer work.

Anyone with a pronounced directional bias for a particular name or names should take note: The volatility curve is very steep sloping downward from the front months -there are a lot of very attractive calendar spread opportunities right now.

On a personal Note: based on the tone of today’s coverage, our friend’s at Bloomberg have apparently decided that it is now time to panic. As you will recall I was miffed when a smirking Bryan Keogh dismissed our thesis that the VXO would reach levels that it hadn’t seen since 1987 as a crescendo signaling a short term bottom for equities. On the 14th, after we were proven correct, volatility levels subsided and Bloomberg’s senior volatility correspondent Jeff Kearns reported that smart money expected that a measure of calm was returning to the options markets –exactly when we made the call that the VIX would test 70 again. It would be tempting now to make a call based on the shrill tone of their latest dispatches as a contrarian indicator but going into expiration at an all time high we might as well try to nail Jello to a tree as call the VIX.

Andrew Barber
Director

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Charting the STAG in Stagflation...

Just a chart. Even if you don't do macro, you'll get the picture.
KM

"Heli-Ben", Please Show Hank The Math...

September’s inflation data is hardly “deflationary”. Conversely, it looks quite sticky when considered on a y/y basis. We define stagflation as the rate of inflation meaningfully outrunning the rate of growth. You don’t need a PhD. in math to realize that +5-9% inflation run rates (see charts) are expansionary. Yes, everything that matters in our models happens on the margin, and yes, both of these upward “Trends” have sequentially rolled over. But do not mistake this as deflation in American consumer or producer prices. Deflation is what you see in your home or portfolio right now – i.e. their prices are DOWN year over year, not UP.

There is a tremendous divide right now between the alarmist Bush administration rhetoric and economic reality. Not unlike their reactive approach to Iraq, Paulson has come out guns a blazin’ and a huntin’ for the evil doers that he can blame for this mess. “Heli-Ben” has his back and is right there willing to drop free moneys from the skies even though the last thing you should be giving to American junkies is more cheap money to borrow. It’s time to take a deep breath. Look at the charts and do the math. GDP in the USA for Q4 is going to be flat to negative, while inflation is going to be up. That’s called stagflation, and you need to raise rates (or stop cutting them) in order to stop it.

KM

Flying a solo mission, for now...

Warren Buffet famously said: “The best way to become a millionaire is to start as a billionaire and buy an airline.” We fully understand the issues that any “investor” has with the airline industry, especially when it comes to applying Porter’s Five Forces to the industry and coming out with a favorable view. That doesn’t mean airlines can’t be good “stocks”, for a “Trade” - look at their outperformance today!

While Keith was giving me the gears this morning and last night when I mentioned airlines as a potential long, like any Portfolio Manager with a process should, and we are not there yet, the chart below does depict an interesting story. In the last few months, the historical inverse correlation between airline stocks and jet fuel has broken down. For many airlines jet fuel is currently ~40% of sales versus 20 – 25% a year ago, if oil, and thus jet fuel, stay at or below currently levels, the y-o-y cost comparisons all of sudden start to look very interesting.

Daryl G. Jones
Managing Director

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